We have downgraded our recommendation on CNO Financial Group Inc. (CNO) to ‘Neutral’ from ‘Outperform’ based on its high financial leverage and constantly deteriorating results in the Bankers Life segment. However, benefits from recapitalization and an enhanced investment portfolio offset the headwinds.
CNO Financial reported third-quarter 2012 adjusted operating earnings of 26 cents per share, beating the Zacks Consensus Estimate of 19 cents. Results were higher than 16 cents earned in the year-ago quarter.
The top-line performance of the Bankers Life segment has been deteriorating over the past few years. Premium collections plummeted 14% in 2010 and 9.6% in 2009. Although collections remained almost flat year over year in 2011, these reported a decline of 9.5% in the first nine months of 2012. The reduced earnings from annuities are mainly responsible for the weakening performance of the segment, along with a marginal deterioration in the health premiums.
Moreover, CNO Financial has a risky business profile with about $1.04 billion of direct corporate obligations. Even the recapitalization plan, implemented in September 2012, increased the debt-to-total capital ratio, excluding accumulated other comprehensive income, by 520 bps from 16.6% as of June 30, 2012.
Also, CNO Financial had to make high principal and interest payments on its outstanding indebtedness, which reduced the cash balance in 2011 and the first nine months of 2012. Moreover, the company required over $122 million in cash to service the debt in 2011 and will likely require $109 million in 2012 for the same.
Nevertheless, the recapitalization plan has boosted the company’s financial flexibility and improved its debt maturity profile. The cost of debt has also reduced by about 210 basis points after the completion of the recapitalization, thereby bringing down the cost of capital. The plan is also expected to enhance the growth rate of the company’s earnings per share and return on equity.
Additionally, the value of CNO Financial’s investment portfolio is steadily increasing. It escalated to $26.36 billion in 2011 from $23.78 billion in 2010, $21.53 billion in 2009 and $18.65 billion in 2008. The value of the investment portfolio increased further to $28.09 billion in the first nine months of 2012. Although underwriting and pricing challenges remain the primary concerns, increasing new business volume, along with cost containment measures are expected to support the bottom line in the long run.
CNO Financial currently carries a Zacks #3 Rank, indicating a short-term Hold. However, another company in the accident and health insurance industry – AFLAC Inc. (AFL) – carries a Zacks #2 Rank (short-term Buy).